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Are Forign Exchange Intervention and Monetary Policy Related and Does it Really Matter?

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  • Karen K. Lewis
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    Abstract

    The relationship between foreign exchange intervention and monetary policy underlies the question of whether sterilized interventions can affect the exchange rate. In this paper, I examine this relationship using data on U.S. foreign exchange interventions from 1985 to 1990, recently made publicly available. I examine whether interventions could be viewed as "signaling" changes in future monetary policy variables. I also consider whether changes in monetary policy may induce interventions in an effort to "lean against the wind" of exchange rate movements. Interestingly, I find evidence both that interventions help predict monetary policy variables, and that monetary variables help predict interventions. These relationships matter for understanding exchange rate behavior only if monetary variables indeed affect the exchange rate. Therefore, I also study the response of exchange rates to shocks in various monetary policy variables. The results provide new evidence on the relationship between exchange rates, monetary policy, and foreign exchange interventions.

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    File URL: http://www.nber.org/papers/w4377.pdf
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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4377.

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    Date of creation: Jun 1993
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    Publication status: published as Journal of Business, April 1995, vol.68: pp.185-214.
    Handle: RePEc:nbr:nberwo:4377

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    1. Lawrence J. Christiano & Martin Eichenbaum, 1992. "Liquidity effects, monetary policy and the business cycle," Working Paper Series, Macroeconomic Issues 92-15, Federal Reserve Bank of Chicago.
    2. Lawrence J. Christiano & Martin Eichenbaum, 1991. "Identification and the Liquidity Effect of a Monetary Policy Shock," NBER Working Papers 3920, National Bureau of Economic Research, Inc.
    3. Bernanke, Ben S & Blinder, Alan S, 1992. "The Federal Funds Rate and the Channels of Monetary Transmission," American Economic Review, American Economic Association, vol. 82(4), pages 901-21, September.
    4. Lewis, Karen K., 1988. "Testing the portfolio balance model: A multi-lateral approach," Journal of International Economics, Elsevier, vol. 24(1-2), pages 109-127, February.
    5. Mishkin, Frederie S., 1981. "Monetary policy and long-term interest rates : An efficient markets approach," Journal of Monetary Economics, Elsevier, vol. 7(1), pages 29-55.
    6. Jacob A. Frenkel & Michael L. Mussa, 1980. "Efficiency of Foreign Exchange Markets and Measures of Turbulence," NBER Working Papers 0476, National Bureau of Economic Research, Inc.
    7. Dominguez, Kathryn & Frankel, Jeffrey A., 1990. "Does Foreign Exchange Intervention Matter? Disentangling the Portfolio an Expectations Effects for the Mark," Department of Economics, Working Paper Series qt84c522k9, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    8. Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
    9. Mishkin, Frederic S, 1982. " Monetary Policy and Short-Term Interest Rates: An Efficient Markets-Rational Expectations Approach," Journal of Finance, American Finance Association, vol. 37(1), pages 63-72, March.
    10. Dominguez, Kathryn Mary, 1990. "Market responses to coordinated central bank intervention," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 32(1), pages 121-163, January.
    11. Mussa, Michael, 1982. "A Model of Exchange Rate Dynamics," Journal of Political Economy, University of Chicago Press, vol. 90(1), pages 74-104, February.
    12. Lewis, Karen K., 1989. "Can learning affect exchange-rate behavior? : The case of the dollar in the early 1980's," Journal of Monetary Economics, Elsevier, vol. 23(1), pages 79-100, January.
    13. Rogoff, Kenneth, 1984. "On the effects of sterilized intervention : An analysis of weekly data," Journal of Monetary Economics, Elsevier, vol. 14(2), pages 133-150, September.
    14. Christiano, Lawrence J & Eichenbaum, Martin, 1992. "Liquidity Effects and the Monetary Transmission Mechanism," American Economic Review, American Economic Association, vol. 82(2), pages 346-53, May.
    15. Michael W. Klein & Eric S. Rosengren, 1991. "Foreign exchange intervention as a signal of monetary policy," New England Economic Review, Federal Reserve Bank of Boston, issue May, pages 39-50.
    16. Frenkel, Jacob A & Mussa, Michael L, 1980. "The Efficiency of Foreign Exchange Markets and Measures of Turbulence," American Economic Review, American Economic Association, vol. 70(2), pages 374-81, May.
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    Cited by:
    1. Ndung'u, N.S., 1999. "Monetary and Exchange Rate Policy in Kenya," Papers 94, African Economic Research Consortium.

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